This Home-Buying Mistake Will Set You Back for Years
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Want to make it as a personal finance guru?
Just tell people to skip the Starbucks and avocado toast and movie nights and pizza delivery. Haranguing cash-strapped Americans about their morning macchiatos has always been an easy way to build a brand as a super-saver.
Want to actually save money? Try paying less for housing.
The enduring popularity of snack-shaming among the early-retirement crowd belies a different, but no less enduring, truth about American spending habits. Millions of people are simply spending more than they should on more house than they need.
Situations vary, but most experts suggest that you spend no more than 30% of your income on housing. And every dollar you save under that 30% threshold is a dollar that can go to savings, investment, or even a higher standard of living.
Unfortunately, a significant number of Americas are spending too much on housing. The latest midyear update to the Bureau of Labor Statistics’ consumer expenditures report makes this abundantly clear.
The first is that a typical household’s take-home pay will be somewhat lower than the pre-tax earnings reported here.
The second is that an average of all households can be skewed by the impoverished, the insanely wealthy, or both — median household income was $59,039 in 2016, which is a far cry from an average household income of $73,207.
The third caveat is that the BLS reports expenditures by “consumer units,” which is essentially any household or individual person who can be considered financially independent.
Luckily for us, the BLS also reported the shares of income devoted to major spending category by five quintiles of household earnings, from the lowest quintile (earning an average of $11,587 before taxes) to the highest quintile (earning $188,676 before taxes.)
From the look of it, it doesn’t seem like any Americans are doing particularly well at living within their means on housing.
Price Matters — Even on the Beach
I’ve been on both sides of the “too much housing” fence, too. While writing for The Motley Fool, I decided to relocate to a beachfront abode on a tropical island, to return to my roots — I was born and raised in Key West. What’s the point of working from home if you’re not making the most of your home, right?
Initially, I looked for places to stay on Key West itself. Unfortunately, I soon realized that even a one-bedroom apartment would eat up quite a bit of my take-home.
Determined to find that beach, I looked a bit further, to the U.S. Virgin Islands. There, I found a larger apartment in a better location, closer to the beach, at about 60% of Key West’s rates.
This involved some changes to my lifestyle, but not many — the U.S. Virgin Islands is, as its name suggests, a U.S. territory. The dollar is accepted everywhere and English is most everyone’s first language.
I even managed to forego car ownership. My apartment was on such a small island that reaching anything useful required taking a ferry across the bay.
Another upside — the island’s reliance on tourism meant that most apartments I saw were furnished, many quite tastefully. No schlepping a couch across the ocean for me!
Prime Location Premium
After a year, I left the island (there were only 200 people there, so it got lonely at times) and relocated to Miami. I rented a furnished high-rise apartment that wound up costing slightly more than the Key West apartments I’d passed over before.
I did this only because my income had risen with my production, so my new apartment was still under the 30% line — just not as far beneath it as my Virgin Islands apartment had been.
The downside to contract writing work is that your production is often at the mercy of forces out of your control, which proved to be the case in the latter half of my year in Miami. It was with great reluctance that I decamped from Miami to a less ideal living arrangement an hour to the north.
I had the great advantage of significant location flexibility during these times, and it’s unlikely that many people would have the same opportunities.
This isn’t to say that it’s impossible for most people to be selective about where they live and where they buy a home. We can look at Miami Beach as one example — although I wouldn’t recommend buying a home in Miami Beach, unless you happen to enjoy the sea creeping closer to your front door every year.
In Miami Beach if you must live on the beach in a prime location, $300,000 will get you…
A studio apartment! That estimated mortgage comes in under optimal conditions, with a 20% down payment on a 30-year loan at the best available rate. It doesn’t include an expected $346 in taxes and insurance costs, either. You do get a few elliptical machines in the apartment gym, so there’s that.
Five miles to the north, just across the road from where I stayed, the same price will get you…
Twice as much space, two bedrooms instead of none, and an additional bathroom. This might be a nice place to live if you’re a single white-collar professional or a married couple with no kids.
Counting the Cost
But in order to buy either of these apartments, you’d be giving up $60,000 in capital, more than $200,000 in interest paid over the life of a 30-year mortgage, and the ability to get someone else to deal with your dishwasher if it breaks.
Every month, your mortgage, plus taxes and insurance, will cost you roughly $1,550. Staying under the 30% line requires take-home pay of approximately $5,200 a month, or $62,400 a year — ranking you somewhere in the upper echelons of the third income quintile we looked at earlier.
If you adopt the optimistic assumption that your Miami Beach apartment will appreciate in value at the same rate over the next 30 years that property in Miami has appreciated over the last 30 years, you’ll wind up with an apartment worth roughly $1.05 million, for which you paid roughly $560,000 in mortgage principal, interest, taxes, and home insurance.
That’s an annual growth rate of 2.12%. And that’s assuming your apartment doesn’t get wrecked and flooded by multiple monster hurricanes in the coming decades.
Meanwhile, if you’d invested your $60,000 down payment in a mixture of stocks and bonds and left it to grow for three decades, you’d wind up with roughly $500,000, achieving an annual growth rate of 7.32%.
If you simply put all your money in the S&P and let it compound for 30 years — and this assumes an average annual growth of 9.5%, which is below the actual average rate of return for the past three 30-year periods in Ben Carlson’s excellent data set, you’d wind up with $853,000.
Be willing to go for less-than-ideal
This assumes that you wind up spending the same amount on rent as you would have on a mortgage. Simply going across the bridge into Miami proper to find a less-expensive apartment gives you plenty of options. Here’s one of them now:
This property, according to Google Maps, is about 16 miles from the first property we looked at. It’s larger than either of the two beachfront apartments, and it’s almost half the cost!
This assumes that we’re still putting down 20%, which in this case is $34,000 instead of $60,000. Instead of $346 in taxes and insurance, your non-beachfront apartment requires about $225 in monthly taxes and insurance instead.
In 30 years, you’ll pay about $330,000, of which roughly $115,000 will be interest and $63,000 will be property taxes. If this apartment appreciates at the same rate as the ones on the beach, you’ll end up with a property worth about $600,000.
However, going with the less-expensive inland apartment allows you to save $26,000 on your down payment, and a whopping $625 a month on mortgage payments.
If you took only $300 of your monthly mortgage payment savings, and put it into the same dead-simple S&P 500 index fund investment strategy that returned 9.5% per year, month after month, over the course of 30 years…
You’d wind up with $852,000.
And an apartment worth $600,000.
And an extra $325 in capital, available to you every month, to use on whatever you want — a vacation fund, a nicer car, more macchiatos, or more investment assets.
And all you had to do was move 16 miles away from the beach.
Don’t Pay To Much For Your Home
Isn’t it incredible how much you can save when you choose less housing than you can afford? It seems like a no-brainer.
But here’s the thing: it’s not an easy decision.
Every influence in your life will tell you to get the best house you can “afford.”
Society will tell you that a big house in a prestigious location is a sign of status and success.
Your friends and family will encourage you to spend just a little more for the house with a swimming pool or a game room.
The rationalizing part of your brain will tell you that an expensive house is “an investment.”
And your ego will tell you that you “deserve it.”
Don’t give in. The excitement of a flashy purchase will last a few weeks or months at most. But the inflated payment sucking your bank account dry every month will last for decades.
Locking yourself into an expensive money pit of a house won’t make you happier, and it certainly won’t make you richer. Here’s the cold truth: every dollar that you can save on a monthly payment is a dollar that you can invest, save, or enhance your standard of living with.
And the best part? If you save big bucks on housing, a latte every now and again won’t hurt the bottom line at all.
Go ahead. You deserve it.